Making Wise Currency Hedging Decisions

The U.S. dollar has benefited from a U.S. economy that has strengthened enough for the Federal Reserve to end its dollar-debasing bond-purchase program and to begin considering the timing of its first interest-rate increase since 2006. That contrasts with Japan and the eurozone, where officials are battling deflation with further stimulus policies amid record-low borrowing costs.

When investing among the three strong reserve currencies, currencies of countries with low interest rates tend to not appreciate as much as suggested by the parity condition.

The opposite holds for currencies of countries with high interest rates. This effect is behind the global currency carry trade where investors borrow in a low-yielding currency and lend the proceeds in a high-yielding currency.

Takeaways

When we eventually arrive in a post-QE world, investors in global equities whose home-base currency is a reserve currency will want to minimize their equity risk by taking short positions in commodity currencies. Those include the Australian and Canadian dollars, the yen and the British pound.

At the same time, they’d be wise to take long positions in the U.S. dollar, the euro and the Swiss franc.

Until then, watch for interest-rate differentials and safe-haven status.

Deborah Frame is vice president of investments and chief compliance officer atCougar.She leads the research team there, including macroeconomic, market environment and asset class correlation research used in the firm’s qualitative and quantitative asset allocation models that focus on downside risk optimization and the use of ETFs.